Can gold act as portfolio insurance?

News Arnulf Hinkel, financial journalist – 19.03.2019

When it comes to portfolio protection, private investors mainly think of derivatives. Although instruments such as futures or options are only available to professional investors, there are leverage and knockout products such as put warrants or CFDs that can be used to carry out covered short sales (uncovered short sales have been prohibited in Germany since the financial crisis). However, the use of these instruments is costly and usually makes sense only for portfolios from a certain size onwards. Gold is a simpler and, in the opinion of many experts, sensible alternative to hedging a portfolio consisting primarily of stocks, as the price of gold generally moves in the opposite direction of the price of equities in times of crisis. 

Gold has a high intrinsic value

While derivatives for portfolio hedging only have an intrinsic value in certain cases – warrants, for example, only are of value if they are "in the money" – and bear the danger of a complete loss in value, gold has a certain intrinsic value at all times, which is determined by the scarcity of the commodity plus the price of the work required to produce it. This value is also the minimum price for gold. Any excess of the intrinsic value is determined by its demand, driven primarily by investors in times of crisis and, in times of economic boom, mostly by buyers of jewellery and gold coins as well as industries relying on gold for production purposes.

Gold does not generate returns

As advantageous as the dual role of gold as both an investment good and a scarce commodity is, the lack of yield opportunities such as interest or dividends has a negative impact: gold really only contributes to the portfolio performance in the event of a crisis. Investors should keep this in mind when adding the precious metal in their portfolio. A possible loss in value of gold within a portfolio could then be seen as a kind of portfolio insurance fee. As explained by Metin Simsek from UBS in a 2018 expert discussion on the German news channel ntv, its application can be compared to that of leverage instruments, which would cost private investors just under 4 per cent of their portfolio value, for example when hedging a DAX-tracking portfolio.

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